The Medford Mug Company is an old-line maker of ceramic coffee mugs. It imprints company logos and other sayings on mugs for both commercial and wholesale markets. The firm has the capacity to produce 50 million mugs per year, but a downturn has cut production and sales in the current year to 15 million mugs. The operating statement for 2015 follows:

At the end of 2015, there is no ending inventory of finished goods. The board of directors is very concerned about the $1.5 million operating loss. It hires an outside consultant who reports back that the firm suffers from two problems. First, Medford Mug’s president receives a fixed salary, and since she owns no share capital, she has little incentive to worry about firm profits. The second problem is that Medford Mug has not marketed its product aggressively and has not kept up with changing market preferences. The current president is 64. The board of directors makes her an offer to retire one year early so that Medford Mug can hire a new president to turn the firm around. The current president accepts the offer to retire and the Board immediately hires someone with a proven track record as a ‘turnaround’ specialist. The new president’s employment contract pays him a fixed salary of $50,000 a year plus 15 percent of the firm’s operating profits (if any). Operating profits are calculated using absorption costing. In 2016, the new president doubles the selling and administration budget to $8 million (which includes his salary of $50,000). He designs a new line of ‘politically correct’ sayings to imprint on the mugs and expands inventory and the number of distributors handling the mugs. Production is increased to 45 million mugs and sales climb to 18 million mugs at $2 each. In 2016, variable costs per mug remain at $0.50 and fixed costs at $20 million. At the end of 2016, the president meets with the board of directors and announces that he has accepted another job. He believes that he has successfully got Medford Mug back on track and thanks the board for giving him the opportunity. His new job will be to turn around another struggling company.

a. Calculate the president’s bonus for 2016.

b. Evaluate the performance of the new president for 2016. Did he do as good a job as the ‘numbers’ in part (a) suggest?

Transcribed Image Text:

Medford Mug Company Profit and Loss Statement Year Ending 2015 (millions of $) Sales (15 million @ $2) Less: Cost of Goods Sold Variable cost (15 million @ $0.50) Fixed cost Gross Margin Less: selling and administration Operating profit $30.0 (7.5) (20.0) (27.5) 2.5 (4.0) $ (1.5)